Fixing the broken housing market in the US

By Joseph Stiglitz

A sure sign of a dysfunctional market economy is the persistence of unemployment. In the US today, one out of six workers who would like a full-time job cannot find one. It is an economy with huge unmet needs and yet vast idle resources.

The housing market is another US anomaly: There are hundreds of thousands of homeless people (more than 1.5 million Americans spent at least one night in a shelter last year), while hundreds of thousands of houses sit vacant.

Indeed, the foreclosure rate is increasing. Two million Americans lost their homes in 2008, and 2.8 million more last year, but the numbers are expected to be even higher this year. Our financial markets performed dismally — well-performing, “rational” markets do not lend to people who cannot or will not repay — and yet those running these markets were rewarded as if they were financial geniuses.

None of this is news. What is news is US President Barack Obama’s administration’s reluctant and belated recognition that its efforts to get the housing and mortgage markets working again have largely failed. Curiously, there is a growing consensus on both the left and the right that the government will have to continue propping up the housing market for the foreseeable future. This stance is perplexing and possibly dangerous.

It is perplexing because in conventional analyses of which activities should be in the public domain, running the national mortgage market is never mentioned. Mastering the specific information related to assessing creditworthiness and monitoring the performance of loans is precisely the kind of thing at which the private sector is supposed to excel.

It is, however, an understandable position: Both US political parties supported policies that encouraged excessive investment in housing and excessive leverage, while free-market ideology dissuaded regulators from intervening to stop reckless lending. If the government were to walk away now, real-estate prices would fall even further, banks would come under even greater financial stress and the economy’s short-run prospects would become bleaker.

However, that is precisely why a government-managed mortgage market is dangerous. Distorted interest rates, official guarantees and tax subsidies encourage continued investment in real estate, when what the economy needs is investment in, say, technology and clean energy.

Moreover, continuing investment in real estate makes it all the more difficult to wean the economy off its real-estate addiction and the real-estate market off its addiction to government support. Supporting further real-estate investment would make the sector’s value even more dependent on government policies, ensuring that future policymakers face greater political pressure from interests groups like real-estate developers and bonds holders.

Current US policy is befuddled, to say the least. The US Federal Reserve Board is no longer the lender of last resort, but the lender of first resort. Credit risk in the mortgage market is being assumed by the government, and market risk by the Fed. No one should be surprised at what has now happened: The private market has essentially disappeared.

The government has announced that these measures, which work (if they do work) by lowering interest rates, are temporary. However, that means that when intervention comes to an end, interest rates will rise — and any holder of mortgage-backed bonds would experience a capital loss — potentially a large one.